Tax Talk: Making Tax Digital for VAT

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The Making Tax Digital (MTD) initiative introduced fundamental changes for VAT in 2019 with the ambition to ease businesses’ tax monitoring and ensure they are paying the right amount of VAT.

From April 2019, businesses with a taxable turnover exceeding £85,000 had to submit MTD compliant VAT returns and maintain their VAT records in digital format. In phase 1 of this process, businesses had to sign up for MTD for VAT with HMRC, digitalise the recording of supplies received and made, and use compatible software to submit their VAT returns to HMRC.

Phase 1 of MTD allowed businesses time to adjust to the new procedures and software requirements, the so-called ‘soft-landing period’.

Phase 2 of MTD marks the end of the soft-landing period and is likely to cause most issues for businesses due to its stringent rules and the introduction of penalties for non-compliance. The incoming essential requirement is for businesses to ensure there are sufficient digital links between data in VAT return workings. A digital link is where a transfer or exchange of data is made electronically between software programmes. This brings an end to the ‘cut and paste’ leniency HMRC has allowed during the soft-landing period. Data must now flow through a business’ accounting software or spreadsheet, to a bridging software if relevant, straight to HMRC. Manual inputting of data will no longer be permitted, and penalties could be levied on businesses that fail to comply.

Phase 2 of MTD was due to come into effect from 1 April 2020 but has now been delayed following the Covid-19 pandemic. HMRC has stated the changes in Phase 2 will now be compulsory for the first VAT return starting on or after 1 April 2021. Depending on a business’ VAT return stagger, this could result in an extension of up to 12 months. The deferral will come as welcome news to those organisations who need more time to prepare.

HMRC published its annual review which highlighted that by 9 March 2020 more than 1.4 million organisations had registered for MTD, with 270,000 of these being small businesses that were beneath the compulsory registration threshold but opted to register for MTD. HMRC’s statistics show that more than 4 million VAT returns have been submitted using MTD compatible software. 

HMRC’s aim is to be a leading digital tax authority and considers the digital preparation and submission of tax returns to be a key step in reducing the tax gap (being the difference between the amount of tax they consider should have been collected and that which was actually paid). HMRC’s statistics are that there is £9.9 billion of tax revenue lost each year arising from “avoidable mistakes” by taxpayers and that MTD “…significantly reduced the opportunity to make some types of mistakes in tax returns, particularly simple arithmetical and transposition errors.“

MTD has been the first step in a fundamental change to the tax administration system and organisations should be aware that the VAT changes are just the starting point. Businesses caught by MTD should review their current VAT return process, to ensure robust digital links are in place. 

Please contact our Indirect Tax Team if you would like to discuss MTD. We can offer guidance and support with your MTD challenges.